Who benefits from inflation targeting?

Many nations are warming to the idea of inflation targeting. By looking carefully at a broad sample of industrial and emerging-economy inflation-targeting countries over time, and comparing them with a control group of industrial non-targeters, it can be concluded that while a target does indeed improve economic performance, its effects vary dramatically depending on the type of economy that attempts it, according to Frederic Mishkin and Klaus Schmidt-Hebbel, the authors of a National Bureau of Economic Research Working Paper.

According to the authors:

Overall, targeters trimmed their inflation rates from an average 12.6 per cent before they adopted the practice to 4.4 per cent after they did:

Emerging economies saw the biggest drop – to 6 per cent after they began targeting inflation.

Developed industrial targeters saw a smaller decline but achieved a much lower rate of inflation – an average 2.2 per cent.

That impressive rate was bested, however, by developed non-targeters, who have averaged 2.1 per cent since 1997.

Targeting nations, especially emerging governments that have achieved their inflation target, see the biggest improvement, according to the authors. Targeting can also help emerging nations go against the flow when inflation is raging worldwide.

The benefits of inflation targeting for non-targeting countries with low inflation and efficient economies are less obvious. The lack of a target does reduce transparency and raises uncertainty. Over the long term, the lack of a target also could reduce the credibility of a central bank if it's not seen as being held accountable to a standard. While it is wrong to say that inflation targeting always helps, the authors conclude, it doesn't seem to hurt in too many cases and may help to stabilise inflationary expectations in an uncertain future.

Source: Laurent Belsie, Who Benefits from Inflation Targeting, NBER Digest, October 2007; based on: Frederic Mishkin and Klaus Schmidt-Hebbel, Does Inflation Targeting Make A Difference? NBER Working Paper No. 12876, January 2007.

For text: http://nber.com/digest/septoct07/w12876.html

For Working Paper: http://www.nber.org/papers/w12876

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 09 October 2007